POWER PLAYS: My Scorecard for Energy M&A

The traditional utility central station business model is under assault by drivers of change over which the utility has little control. In my recent post Utility Merger Mania? I talked about the factors I felt would drive utility mergers and my differences with the factors S&P’s Todd Shipman (whom I know from my days as president, Global Energy Advisors division of Ventyx, now an ABB company). Todd Shipman suggests ‘25 in 5’ as an expectation of the utility consolidation ahead.

I feel S&P is too timid in their analysis falling back on ‘fighting the last war’ during the rage of divestiture of power generation by utilities to secure stranded cost recovery saw the rise of merchant power generators as a key industry segment. That forced change to the traditional vertically integrated utility business model has been an unqualified success diversifying the portfolio, improving power plant performance, driving new technology adoption and opening the door to renewable energy faster than we would have seen it before. Wholesale power generation competition worked!

The factors driving change in the utility business model today set up an even bigger opportunity to improve the utility business and open the doors to new entrants bringing new ideas, new technologies, and new motivation for profits that can have the same advantageous effects.

I say the only thing left standing of the traditional utility business model at the end of this transformation process now underway will be a regulated wires and pipes business where regulation enforces technology standardization, maintenance requirements, safety and open access. Everything else will be fragmented into competitive segments of:

wholesale supply,

transmission and energy delivery,

energy management services,

optimization and trading and

customer aggregation.

Customers will have choices of vendors, technologies of supply all priced to fit their preferences and risk. A better business model for the remaining wires and pipes utility might actually be Amazon or eBay which offers intermediary buying services, reviews, qualifying and insurance protection from scoundrels with assurance of delivery. The last big fight for the traditional utility will be over the gateway to the customer and with it the utility can be the customers’ best ally in screening, qualifying and policing vendors and providing backup and insurance services when stuff happens.

Customer aggregators will offer competing services bundling affinity groups or neighborhoods into package deals of varied services and price points. The marketplace will be filled with choices and choice brings confusion so customer aggregators and constant energy management service providers will take care of us, fight for the best deals, and make sure we are happy and the lights stay on at prices we believe are competitive. This will be the retail energy future we once imagined except it isn’t about energy. It is about convenience, comfort, security, bundling of services, technology access and management, and value.

The Need to Think Big about Energy M&A

I said S&P was being too timid in its thinking. This next wave of utility business model change is already underway with the death of a thousand cuts driven by the factors of change I discussed:

Low Growth Rates

Rising Cost

Regulatory Uncertainty

Technology-driven Scale

Foreign Direct investment

Game-Changers

This next wave of change will blur the lines between traditional utilities, their vendors, substitutions, and customers. From energy storage to home area networks and zero-net energy buildings transforming technologies threaten to change the game utterly. Our national energy policy creates more uncertainty, drives up costs, and threatens to strand both traditional utility players and new technology investors by the fickleness of politics, industrial policy choices of winners and losers based upon the spending prowess of lobbyists, and our geo-political financial and market dynamics that just didn’t exist twenty years ago with the last wave of change began.

If you are a utility CEO in this uncertain market environment a wave of M&A is beginning with traditional utility players circling the wagons and the executives without chairs when the music stops get a big payday. For many this is a dream come true. For others it is their nightmare scenario.

I wanted to have a way to blend these different players into one framework when considering the advantages and disadvantages of energy M&A deals. I wanted to think beyond the merger of similar utility players to include the bad boys of technology and the game changers in other industries, markets and nations.

POWER PLAYS is my scorecard template to categorize the evolution of the industry its take place:

TRADITIONAL

Recent combinations such as Duke/Progress Energy, First Energy/Allegheny and NU/NStar represent more a circling of the wagons than any kind of revolutionary thinking about the electric power future.

Expect the early round transactions to be more traditional plays where the utilities seek to secure their regional market leadership, improve earnings, spread rising costs over a wider rate base and fortify themselves against future expected onslaughts from much more disruptive transformational technology and business model plays from outside the industry. The best defense of these traditional utility players will continue to be the state-by-state rate regulated nature of the monopoly utility industry and the fragmented approval process for any transactions. I wrote earlier about the need for traditional utilities to innovate or die to survive the transformation process ahead. We’re seeing both innovation and panic setting in across the business.

INNOVATORS

Some utility players have sought to differentiate using the unregulated side of their business to diversify across markets, build scale in new technologies, and position their business for more satisfying growth. Examples of this type include the nuclear operator giants Exelon and Entergy, the FPL morphing into solar leader NextEra Energy, and PG&E’s focus on living into the 33% RPS California goal.

On the public power side Austin Energy, Seattle City Light and SMUD are three candidates for this category driven forward by public support for their renewable energy goals.

Xcel Energy sought to move from traditional to innovator with its embrace of renewable energy and early investor experimentation with SmartGridCity but it also revealed the biggest risk for utilities in breaking with tradition—stuff happens. The failure of SmartGridCity set back Xcel Energy and discouraged other utilities from sticking their necks out.

DISRUPTIVE

This is venue of trouble-makers eager or willing to use new technology, new business strategies, dynamic pricing and other methods to disrupt the status quo and change the rules of the market. Many of the bleeding edge utility players flirt with aspirations of being a disruptive leader but often chicken out.

Disruptive players are more likely to try to break up the traditional vertically integrated utility than to buy it. Plays that divest the power generation portfolio to merchant generators were the rage in the last round of utility business model change as wholesale competition was introduced in 1992 with the Energy Policy Act. For traditional utilities seeking to escape the rising risks and costs of a coal-based portfolio and replace it with a blend of more environmentally acceptable resources we could see more divestitures of coal plants. These disruptive players will come from outside the traditional utility industry ranks such as merchant power generators, energy services companies or major technology players seeking to insert themselves in the value chain or jailbreak utility customers from their traditional suppliers.

This is also the province of the major renewable energy players, smart grid/smart meter technology plays, energy management companies like EnerNOC, CPower or Comverge. The problem for most of this disruptive plays is they must straddle the market fence since utilities still have the money and make most of the technology buys, energy supply buys and mostly still control the gateway to customers.

On the public power side, the best opportunities for disruptive plays is in community customer aggregation in California a devilish opportunities for cities and counties to form buyers co-ops of retail customers to jailbreak themselves from PG&E, SCE or SDG&E in the Golden State. In Texas it is retail energy services companies offering direct access in competition with the traditional investor owned utility players.

The other potential disruptive plays could come from foreign direct investment in the US seeking to gain market share. We have been sanguine about UK and European utilities buying stakes in US companies including National Grid, Iberdrola, EdF, and E.On but US regulators stopped previous Chinese purchase of oil company and other strategic assets, but times may be changing.

TRANSFORMATIONAL

Transformational plays by their nature suck the oxygen out of the room by utterly changing the game for all. We can imagine some of the potential transformational plays but, to date, there are few that really keep the utility CEO up at night.

Energy storage, plug-in electric vehicles, fuel cells, fusion are examples of the most commonly thought transformational plays but each is a long way from proving they can cost effectively change the game.

Better examples of transformation plays that are limited more by policy than technology on the horizon include Tres Amigas Superstation, the energy hub project that bridges the gaps between the WECC, ERCOT and Eastern Interconnect enabling the sale and movement of renewable energy and other resources across the formidable barriers between the interconnects. There are a few power plants that straddle the grid boundaries converging power from AC to DC and back again to export it from one grid to another but the transfer rates are limited. Tres Amigas is transformational because it points the way toward energy hubs that enable wide scale bridging of the grids and thus makes possible the scaling of smart grid and its players.

For the same reasons, a growth in the use of National interest Electric Transmission Corridors (NIETC) would transform the power markets creating transmission super highways of high voltage DC backbone transmission running east and west and jailbreaking ERCOT from its isolation. US DOE and FERC have been VERY reluctant to use NIETC for fear of a fierce firefight with states that now control transmission siting. Two such corridors exist today on the Southwest for solar energy and in the Mid-Atlantic but US DOE must do a new congestion study every two years and each update will provoke a new debate.

Other transformational plays are expected from the major IT/OT players such as IBM, GE, CISCO, ABB, Siemens and others using middleware and optimization services to take control of the flow of electrons and the management of efficiency, demand response, capacity factors, power plant performance and use of the immense data output from smart meters to change the way the power grids work. This is not to suggest that these players will acquire traditional regulated utilities. They won’t have to do so, they will contract to provide energy management and optimization services that will give them de facto control of grid operations on a continental market scale.

So there you have my basic POWER PLAYS typology. My objective here was to think about a framework to consider possible mergers between utilities not to predict specific deals. Now we await the mischief—and the opportunities.

You might, however, be interested in looking at a few earlier posts I did on the smart grid-enabled energy technology side of the business offering ideas for my “Dream Team” candidates for technology M&A including: